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Software Ray of Light for Sun

Sun Microsystems must rely on software to return to profitability.

Microsoft's(NASDAQ:MSFT)dividend payout and buyback announcement yesterday has dominated business news and even made its presence felt in Sun Microsystems'(NASDAQ:SUNW) fiscal fourth-quarter and year-end earnings report. Because of its $1.95 billion April settlement with Microsoft, Sun posted a profit of $795 million in its earnings report yesterday.

Once Microsoft is taken out of the equation, however, the numbers are dramatically different. Sun actually lost $169 million in the fourth quarter once the settlement and restructuring changes were excluded. In addition, excluding the settlement means that Sun's cash flow from operations declined nearly fourfold in fiscal 2004 compared with 2003.

Not all of the numbers are bleak, though. Sun does have a strong cash position and continues to be cash-flow positive. It also experienced growth in all three divisions (hardware, software, and services). Total shipments of servers in the fourth quarter increased 46% year over year, aided by the global increase in demand. Its services division also exceeded the $1 billion revenue mark this quarter for the first time. The ratio of revenue generated by products and services remains constant at 2:1.

However, it was in its software division that Sun really shone in the quarter. Subscribers to its Java Enterprise System grew by 74% year over year, and Solaris and Java downloads continued to grow. Sun has identified Solaris and Java as two of its key franchises in the quest to be the center of enterprise computing, and the growth in these two areas is essential to its bottom line. If Sun is to have any hope of posting a profit without Microsoft's help, it has to successfully make the transition from a hardware company to a software company.

In the short term there is a lot of uncertainty about Sun. The company still does not give earnings guidance, and analyst estimates for fiscal 2005 run the gamut from a profit of $0.15 to a loss of $0.10 per share. Sun may have slowed the bleeding from a $3.43 billion loss in 2003 to a $376 million loss in 2004, but investing might still be unwise until it shows more progress in returning to profitability.

What's your opinion of Sun's results? Talk about it with other Fools on our Sun Microsystems discussion board.

Fool contributor Tim Goh does not own stock in any of the companies mentioned.